The clock is always ticking when it comes to meeting finance and accounting deadlines. But some deadlines loom larger than others.
That’s certainly the case with the new lease accounting standards as set forth by the Financial Accounting Standards Board and Governmental Accounting Standards Board. Public entities and certain nonprofit organizations were subject to the new standards several years ago and now, after a period of delay, all other entities reporting under generally accepted accounting principles will be required to follow suit by formally recognizing all leases (with a few exceptions) on their balance sheets.
In short, operating leases were previously “off the books” and relegated to footnote disclosures. Now, these leases, like their companion finance leases (previously called capital leases) are going “on the books.” As with any such change in professional standards, the goal is laudable: to increase transparency and comparability in financial reporting.
But the practical effect is that your organization’s balance sheets and ratios may look very different as a result, despite no material change in business activities, potentially affecting your covenants and positioning with investors, banks, or other stakeholders.
Pain points ahead
The biggest pain point is likely to be simply uncovering all the leases you weren’t aware of, or recategorizing something that might not have been previously considered a lease. Our clients have been surprised at the number of possible embedded or “hidden” leases that they had to consider.
Look around your office or job site. Do you see assets that don’t belong to you, such as coffee machines, modems or copiers? Potted plants? Security systems? What about portable toilets or dumpsters on a construction site? Even advertising agreements for a billboard may qualify. Most clients are surprised at the volume and variety of these potential lease contracts.
Then, of course, there’s real estate, which may be more obvious to categorize as a lease but also typically involves much more complex arrangements to parse. Complicating factors include the allocation of lease payments to the various components of the contract as well as the accounting for parking spaces and non-coterminous land (land not underneath the building), just to name a few.
It's going to take a great deal of time and resources to dig into the underlying contracts, your general ledger, and the professional literature to discern how to properly follow the new rules and determine the impact on your financial statements. The longer you wait, the more difficult it will become to address. Many of our clients who have gone through the process found it took twice as long as anticipated to complete — even more reason not to delay.
Despite these challenges, our clients have also found opportunities that can arise from this now-required activity — if done properly. Spending time analyzing expense accounts, commitments on service contracts, and other potential lease agreements can provide valuable insights and prompt beneficial conversations. Consider the following possible benefits.
- Uncovering unfavorable lease terms
Once you’ve closely examined lease agreements, you may find some contain terms that are less favorable for you. Is the term or pricing out of sync with the current environment and strategy? Sometimes it is worth paying a termination penalty rather than continuing with the current contract terms. Perhaps you will be able to renegotiate a more favorable agreement altogether.
- Reconsidering contract commitments
Upon reflection, you may determine that some contracts are no longer needed. These agreements may have been set to auto-renew simply because of inertia or because of their embedded or opaque nature. Consider if cost structures have changed to the point where it might make more sense to buy rather than lease. Might individual contracts be combined into fewer, centralized agreements to reduce costs or find efficiencies by working with fewer vendors? Are there duplications that can be eliminated?
- Reducing risk
An in-depth review is an excellent opportunity to examine your processes and policies around contracts to reduce risk for your organization. Are the right people vetting, approving, and signing the contracts? Is the organization retaining the documentation in the most effective way? There may be opportunities to improve upon the process going forward for greater clarity and transparency.
Help is available
As we’ve noted, and as those who have previously implemented already know, this process may not be easy, and it can’t always be done quickly. If you haven’t already started, now is the time to designate the resources to help the standards get implemented properly and on time. It may be prudent to seek help from a third party — but be aware that the longer you wait, the more limited those resources will become. Everyone else will likely seek assistance to hit the deadline at once, making this a more expensive option over time.
Additional help might come in the form of various lease accounting software tools. There are numerous informational and continuing education sessions available to help you think through this process as well.
But don’t wait. It may cost you.
Not sure where to get started with lease accounting? Click here to learn more about tools and services available, including a free CPE-eligible webinar.
*This article originally appeared on the The Business Journals and is reprinted here with permission.